Photographer: Kevin Lee/Bloomberg

China Has Returned to Reform Mode

Updated on
  • Plans announced to open sectors, cut overcapacity, reform tax
  • State Council reaffirms commitment to complete reforms by 2020

China has returned to reform mode.

This week, plans have been unveiled to quicken the clean-up of excess capacity in state-backed companies, level the playing field for private and foreign investors with new access to previously off-limit sectors, and take the next step in a long-awaited fiscal shake up.

Having stabilized the economy with a mix of fiscal support and easy monetary settings, China’s leaders appear to be reviving a stalled reform push that’s key to long-term growth prospects. The rush of announcements comes ahead of China’s hosting of leaders from the world’s 20 biggest economies in Hangzhou on Sept. 4 and 5, allowing it to show progress to officials from nations such as the U.S. and bodies like the International Monetary Fund that have called for structural changes.

"The pace of reform had been slower than expected," said Shen Jianguang, chief Asia economist for Mizuho Securities Asia Ltd. in Hong Kong. "Now, policy makers want to speed it up again. With monetary easing proving less effective in propping up the economy, they have realized that there’s no way out if they don’t push forward on reform."

The People’s Bank of China has been upping its communication in recent weeks, signaling ongoing use of liquidity tools rather than big gun moves such as cuts to benchmark interest rates or the percentage of deposits banks must lock away as reserves. With businesses hoarding cash and reluctant to invest, further easing risks fueling financial risks without spurring a pick up in economic growth.

Reflecting varying views in policy making circles, a researcher at the nation’s top economic planning body said China has a lot of room to guide interest rates lower. Financing costs for Chinese companies are still high, and the country should keep liquidity "reasonably loose", Cao Yujin, a researcher at the National Development and Reform Commission, wrote in a commentary published at the commission’s website on Friday.

"It seems that Chinese regulators agree that they want to reduce financing costs but do not agree on the method of doing so," said Andrew Polk, Beijing-based director of China research at Medley Global Advisors LLC. "It’s the methodology debate that puts NDRC at odds with the PBOC."

New Approach

The conventional use of reserve ratios or rates cuts is "no longer consistent with the market-oriented supply-side structural reform," Raymond Yeung, chief greater China economist at Australia & New Zealand Banking Group Ltd. in Hong Kong, wrote in a note this week. "The PBOC is attempting to modernize China’s monetary policy setting in a way consistent with Xi’s reform strategy."

Yeung expects the PBOC will stay neutral for an extended period in order to avoid potential property and financial bubbles, forecasting the 7-day repo rate of around 2.25 percent until the end of 2017.

For Bloomberg Intelligence’s take on the PBOC’s policy stance, click here

In the latest move Wednesday, the PBOC injected cash into the financial system using 14-day reverse-repurchase agreements for the first time since February. That was interpreted in different ways, with some economists seeing it as a ploy to curb leverage in the bond market, while others saw it as a plan to flesh out the short-term yield curve.

The brakes are being applied elsewhere too. Authorities in Shanghai are preparing a fresh round of curbs aimed at cooling the city’s soaring property market, including potential restrictions on mortgages and loans to developers, according to people familiar with the matter.

Chinese leaders in 2013 charted an ambitious plan to add market forces in the economy, with reform measures aimed at doubling the size of the economy by 2020 from 2010’s level. Progress has been made in some areas, such as the scrapping of the one-child policy and interest-rate liberalization, and slower in others, with bloated state-owned enterprises still having advantages over private players in many sectors.

For a QuickTake on China’s bumpy embrace of market forces, click here

Almost three years since the Third Plenum overhaul was laid out, the government has to quicken the pace of change or reforms won’t be wrapped up in time, said Mizuho’s Shen.

Here’s a snapshot of the latest announcements:

  • China’s National Development and Reform Commission, the government’s top economic planning body, said Tuesday that private capital is welcome in more sectors including so-called "strategic" ones like oil and gas drilling. "Political barriers" for private investment will be removed to offer a fair playing field and encourage non-state companies to take part in 165 projects outlined in the country’s 13th five-year plan.
  • Also Tuesday, the vice minister of commerce said China will slash limits and continue opening its education, finance, culture and manufacturing sectors to foreign investors. Measures will focus on boosting investment in inland, western regions.
  • China will cut overcapacity at central-government controlled companies by about 10 percent within two years, the Economic Information Daily reported, citing the State-Owned Assets Supervision and Administration Commission, the country’s top watchdog on state assets. SASAC last week unveiled a trial project to allow employees at SOEs to own shares in the companies to boost motivation and morale.
  • Late Wednesday, the State Council said China will improve the fiscal relationship between the central and local governments and establish a system that splits expenditure and fiscal responsibility at different levels of government. The State Council, China’s version of a cabinet, also said it will complete reforms in major sectors by 2020.

Still, skepticism remains as to whether reforms will be carried out. The latest guidance on SOEs doesn’t contain enough "sticks" to change the behavior of state-owned firms, Natixis SA economists wrote in a note Monday titled, "SOE Reform in China: Loud Thunder Small Raindrops." A follow-up note Tuesday questioned whether the NDRC plan to attract private investors would prove successful and said "we do not expect the role of the state in production to be reduced any time soon."

Even taking the quickened pace of reform at face value, rolling out of such plans will likely be gradual. It will take some time to generate significant and material improvement on the ground, said Donna Kwok, senior China economist at UBS Group AG in Hong Kong. The near-term significance may be that progress is being made.

"With an intensifying and more varied stream of announcements, policy makers are making it clear that reforms are on track," Kwok said. "If the market sees signs of progress, without any major downside impact to near-term growth or employment, confidence might improve."

— With assistance by Yinan Zhao, and Miao Han

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